August 31st, 2010

One of the definitions for austerity in The American Heritage Dictionary is “severe and rigid economy.”  One of the definitions of rigid is “marked by a lack of flexibility.”  Austerity is one of the last things people want to think about or face, but when you combine these pieces of the two definitions you have “severe and marked by a lack of flexibility.”  Welcome to the economy of 2010 and probably several years in the future.

The longer the economy’s trend is generally sideways and not generating enough momentum to put a dent in unemployment, the more likely it becomes that we might slip into a second recession, maybe even more toward deflation.  Starting early in this decade Americans went on a spending binge fueled largely by dramatic increase in housing prices.  Consumers used these rapidly increasing values to borrow against to buy whatever their hearts desired.  The good times were rolling.  Because consumers wanted to buy, manufacturers ramped up production and expanded and hired new workers to meet the demands.  Real estate developers had to build new shopping centers to give people more places to spend that money.  Then the music stopped.

The music, which had been fueled by the dizzying increase in home prices, was orchestrated by many different kinds of cheap (at the beginning) mortgages.  But all of these mortgages had specific times where they would reset to whatever the market rate was at that time.  Suddenly when people had to start making regular payments on mortgages that looked so good when they got them, they couldn’t and started to default, and it hasn’t stopped yet.  Since these mortgages had been bundled into packages and sold to banks, investment firms and others, as more and more mortgages started to default the mortgage packages started collapsing, banks began to get in trouble, so they dramatically cut lending.  As a larger and larger number of people started buying less, companies that had increased plant and equipment to meet the demand started to cut costs to maintain profits or just stay in business.  Much of this cost-cutting was by laying off people.

Suddenly, there was too much stuff and not enough people to buy it.  Manufacturers and producers couldn’t raise prices, and if they can’t raise prices to keep revenues and profits up, they aren’t likely to invest or hire.  So today, all of this – declining housing prices, stagnant sales and hiring – begins to put the economy closer and closer to another recession.  In addition, if by some chance we do begin to experience any deflation, the normal the way to counter it is to ease credit so that people will be more inclined to spend.  But that option has been already been attempted by the Fed, interest rates are practically lower than they have ever been, and nothing is happening.  If the current bias in Washington and the country is against more spending to increase economic activity, then another door will close.  What may be one of the only options left is just to suck it up and suffer through it until natural economic forces come into play and end the recession.  A market-imposed discipline on consumers to live more within their means and save more will finally create a larger pool of savings that can be invested and spent once the economy begins to recover.  How and when it will begin to happen, nobody knows.  But it will happen.

Yesterday the Washington Post ran a story entitled “Fed policy foggy as the economic picture clouds.”  In there was this statement: “… Fed Chairman Ben S. Bernanke is under rising pressure to offer solutions in his address Friday that is likely to be his most important since the end of the financial crisis.” The last time I checked there were seven members of the Board of Governors as well as the presidents of the twelve regional Fed banks.  Bernanke can’t fix it single-handedly no matter what he says today.

President Obama didn’t start the recession and can’t fix it himself.  President Bush, the same.  But in today’s world of political polarization, the twenty-four hour news cycle, and thousands of political blogs screaming to be heard, the tendency is to blame one person or entity.  There also happens to be those 100 senators and 435 House members at the other end of Pennsylvania Avenue, and as much as I hate to say it, they are not solely responsible either.  But they more than anyone else could go a long way toward fixing it.  At the rate we’re going, they may actually have to work together and try.  The longer the recession drags on, the more unhappy many of their constituents are going to get, and even though it is only dimly on the horizon right now, there is another and even bigger election coming in two years.

But in reality, as Pogo said, “We have met the enemy and he is us.”  The us is all of us collectively.  We live in a free enterprise society where some clever mortgage company figures out how to offer a too-good-to-be-true mortgage – no down payment, no verification of income, no payments for ___ months, take your pick, and lots of people disregard or don’t look at the risk, use it to buy a house, and the mortgage company gets rich.  Then some clever investment banker figures out how to take those mortgages, bundle them together, cut them into pieces and sell each piece to separate investors, and the investment banker gets rich.  These examples and thousands of others are free enterprise in action, right or wrong.  Nobody forces people to buy, but when something goes wrong, people want to shift the blame from themselves for being stupid or greedy, so it’s directed at people and entities that cannot wave a magic wand and fix everything. 

The longer that the recession drags on, the more painful it is going to be.  There is enough blame to go around, but don’t place the blame in one place; except the mirror.

9.5% unemployment is now a crisis.  Add on top of that another roughly 7.6% considered “underemployed” that doesn’t get as much publicity, and there you have a real crisis that is not going to improve any time soon.  And why should it?  The explosion of the housing bubble set in motion a series of precariously standing dominoes that started toppling into each other – starting with the banks.  As bank losses suddenly started to mount as more and more subprime loans started to default, they largely stopped lending to all but the most creditworthy businesses, so businesses started to scale back to cut losses and one of the easiest ways was to eliminate employees.  At the same time the value of most peoples’ largest assets – their houses – was starting to fall, so more and more people began to curtail their spending including in many cases, their mortgages.  Mortgage defaults and foreclosures are continuing to rise.

We now find ourselves in a position where the economy has probably bottomed out, but there is nothing in sight to indicate that any meaningful move upward is coming.  The economy needs consumer spending to drive it, but many people aren’t spending either because they have lost their jobs or are afraid they might.  Because of this same fear we now see a sudden increase in personal savings and deleveraging, all of which militates against consumer spending.  So here we are going ’round and ’round – no jobs; no spending; no spending, no recovery.  Then we throw in the wildcard of the November elections and we can be almost sure that nothing major is going to happen to shock the economy into recovery because of the new push for deficit reduction.  So as I said earlier, why should the recession end?  We get some positive news one day then bad news the next.  The positives have been outweighing the bad, but not by much, and it is “much” that we need to turn the economy around.

Now add one great big question – when the economy does start to improve, will people be able to go back to the jobs they had before the recession?  In many cases, the answer is no.   Manufacturing is the poster child for economic recovery.  America needs to regain its leadership in worldwide manufacturing.  ‘Ain’t ‘gonna happen.  For one thing, a huge amount of manufacturing has gone overseas and will never be back, so those jobs are largely gone forever.  As important is the fact that in many industries technology has improved so much that productivity has continued and will continue to increase without adding employees to do it.  One fact describes this perfectly.  According to the Federal Reserve Bank of Chicago, what took 1,000 workers to manufacture in 1950 could be produced by 184 workers in 2009.  There is a problem for the economy that will never go away.

The continuing process of creative destruction is seeing to the fact that many jobs that once existed in certain industries are gone forever.  What are people going to do who have skill sets tailored to types of jobs that no longer exist in any quantity?  What are they going to do to create new skill sets as the ones they have erode with long periods of unemployment?  What are they going to do when they can’t move across the country to where new industries might be springing up because they can’t sell their houses?  What kinds of jobs are going to exist or be created that will begin to absorb millions of people out of work now?  How are politicians going to explain why they can’t fix the problem?  Eventually after blaming each other long enough, it will be apparent that they all are guilty, Democrats and Republicans.  Then what?

Use SBA!
August 20th, 2010

Back in February 2009, which now seems like several lives ago, as part of the stimulus package the SBA loan guarantee was raised to 90%, and many fees were also waived.  SBA lending exploded.  How odd.  Wonder why that happened?  Wonder if Congress understood why it was happening, or even knew?  The SBA’s fiscal year ends in October, and in fiscal 2009 loan volume was down 36% from 2008.  But, since the changes in the stimulus package didn’t go into effect until February, it took some time for lenders to ramp up and when they did, loans increased dramatically.  So the 2009 fiscal year decline was not really indicative of what was beginning to happen, and if you pick March as a realistic date for lenders to really begin to increase their SBA loans there were only eight months left in the fiscal year.  September turned out to be the best month of the year, and loan volume was strong.

But the stimulus package had an end date so SBA was going to have to return to their normal guidelines, mainly the 75% guarantee.  Congress, in its infinite wisdom, somehow realized that this was actually doing some good, so they extended it briefly.  But finally they couldn’t stand it because stimulus was spending money (which was bad in their eyes), so they let it die.  Loan volume died back with it. 

 So there is a government program – SBA – that generated 44,221 loans for a total of $9.3 billion in a terrible year for the economy.  How many small businesses might have gotten loans without the guarantee?  How many of those loans either created or saved jobs?  How many other things that the government is trying to do to boost the economy can have such an immediate effect as SBA small business loans being made somewhere in the country every day – no new program to fund and set up; no ramp-up needed.

Now look at one more thing that SBA’s detractors often point to, the default rate.  Let’s assume that it’s 10%.  That’s 4,422 loans, but because they defaulted does not mean that everything was lost.  Banks always require collateral, and SBA requires banks to liquidate the collateral before making good on the guarantee.  So, for example, a bank might liquidate the collateral and recover 10% of its value, so SBA would only have to give 65% of the guarantee to the bank.  So it was not a total loss to the government.  But the important number is the 39,798 loans for $8.3 billion that did not go bad, and the benefits that were created for the economy.

The economic numbers so far this week have been grim.  Small business creates jobs.  SBA works.  Why doesn’t Congress?

When the economy begins to recover in a meaningful way with new jobs being created (and that is being pushed farther and farther into the future), there is something growing beneath the surface of the economy in at least two places that will help feed it, and that is cash.  Because of the major cost-cutting by many large corporations since the beginning of the recession, much of which has been accomplished by laying off workers, profits and therefore, cash, are increasing without having to hire more workers than they have now to generate them.  So there is more and more cash accumulating on many corporate balance sheets as sales begin to increase.

Then there is the personal savings rate which has jumped from near zero three years ago to somewhere in the neighborhood of six percent now.  That is also creating a pool of cash, in this case, on consumers’ balance sheets.  The fact that all this cash is not being spent right now is a drag on the economy, but whenever the economy does start to improve, that accumulated cash may give an unexpected boost to the recovery as companies begin to ramp up production and consumers begin to gain confidence and start spending, because they will already have cash and not have to think about borrowing it.  We can only hope. 

We can also pretty much rest assured that nothing significant is going to happen between now and the November elections to aid the economy.  The Republican Party is drooling over the prospect of large gains in the mid-term elections, so they will be even more adamantly opposed to anything the Democrats might dare to attempt to help the economy.  On the other side of the aisle, the Democrats are so busy fighting a rear-guard action to stave off the Republicans that they wouldn’t be likely to do anything anyway.

Then once the elections are over, there will be a period where Republicans try to figure out what to do with their new-found muscle, so not much is likely to happen right away after the elections either.  So we can probably write off 2010 in terms of any meaningful help for the economy from our worthy representatives in Washington.  And, depending on how the elections do turn out, it is almost sure that there will be new emphasis on deficit reduction, so the economy is not going to benefit from that either in the short term.  Whatever happens, neither party will be likely to be able to ramrod through any controversial programs, and even if the Republicans have a majority in the House, they still face a Democratic president who has veto power.  So stay tuned.

We Don’t Have World War II This Time

With all the efforts being made to bring the country out of the Great Depression, it was the advent of World War II that really brought an end to the depression as the country geared everything up for war.  We are not in the Great Depression, but we are in a major recession and there is no World War II to bail us out.  And things are getting worse; there is not much good news around now – it’s almost as if we are watching a slow-motion train wreck.  As one of the many negative indicators appearing on a regular basis is this paragraph from the minutes of Tuesday’s FOMC meeting:  ”Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract. Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”  Really??????????

When you start hearing this kind of language from the Fed, you know things are really getting worrisome.  More and more signals are pointing to an extended period of economic malaise – four or five years, and maybe longer, with persistently high unemployment and low consumer spending.  Exports for example, are an important economic engine for growth, but the U.S. trade deficit widened unexpectedly in June, with China again part of the problem, and we are still dealing with weak economies in Europe.  We are spending billions on two wars, with questionable outcomes that could be far better spent here.  More and more technology is replacing workers in various industries, and those are usually jobs that will not be coming back because technology continues to improve.  Where are so many people going to find jobs?  What are they going to be able to do?  There is still a strong enough economy to probably keep it from falling back into recession, although that is beginning to look questionable, but it is not strong enough to move the economy forward with the strength necessary to begin to put people back to work.  Four out of five people still do have jobs and they are spending.  But in many cases they are spending cautiously so that it is not enough to really give a boost to the economy.  It is enough to keep us from sliding back into recession (hopefully) but not much more.  Private payrolls that exclude government agencies increased by 71,000 in July.  The economy needs 100,000 new jobs a month just to keep up with new entrants into the labor force, and another 200,000 per month to start putting a serious dent in the unemployment rate.  We’re not quite there yet.

In a time of crisis like this, an interesting question to ask is “Where have all the statesmen gone?”  An appropriate answer might be, “To see a lobbyist about raising money for the next election.”  That may be a little harsh.  But in times like this we need a government that can unify and make hard decisions and tough choices for the benefit of the whole country, and not the biggest donors and loudest screamers.  Sadly, we don’t have that right now which bodes ill for any hope of a strong recovery. 

Which brings us to the plight of many small businesses.  Since small businesses live at the bottom of the food chain, it may be prudent to think about what their business might look like after three or four or five years of a stagnant economy.  One thing is fairly likely, and that is that banks are not going to suddenly jump up and start lending.  There is too much risk, so for companies that need it, financing is going to remain a problem.

We are in a mess and it’s going to get worse.  Inflation has been a bugaboo in this country for a long time, and the Federal Reserve has all the tools necessary to deal with it.  Generally, as prices go up in inflationary periods, people are inclined to buy before prices go up any more.  Companies that produce what people want to buy are usually able to keep ahead of them and make profits.  As this recession drags on, more and more people have started buying less, and in some cases, dramatically less.  Many companies are not making enough money (forget the very large companies that are making significant profits because their sales are increasing but they are not adding workers), so they start to cut back – usually starting with eliminating employees.   At this point in the recession, inflation is almost non-existent.  The Consumer Price Index is hardly moving.  The Fed has lowered interest rates almost to zero, and nothing is happening.

So if inflation is not a worry because people are not buying as much, if a company can’t sell their product at its current price, they may have to lower it.  If their costs can’t be lowered as fast as the sales price it puts an additional squeeze on their profit margins.  In a similar situation, if a homeowner can’t sell their house for what they paid for it a few years ago, they may have to lower the price, possibly resulting in a loss which then may have a negative effect on their spending on other things that they might have bought before.  So if a potential buyer for either the house or the product thinks the price may go down tomorrow, the buying decision may be postponed.  If enough buying decisions are postponed, it could lead to further declines in prices, which leads to deflation.  Deflation can be a major problem in an economy that needs spending, which ours does.  At this point in time, not many observers think any serious deflation is likely, although it is creeping more and more into peoples’ minds. 

So what’s left?  Stagnation – not much movement in either direction – and this only pushes a recovery farther away.  Stagnation is reinforced by high unemployment, and when you hear the Secretary of the Treasury Timothy Geithner saying last week that unemployment could go up before it goes down, that is not a pretty picture.  There are currently something like 7 million people who have been out of work for more than six months.  The longer they stay out of work the more their job skills could deteriorate making it even harder to find jobs when the economy does finally start to improve. 

Suddenly it begins to look like stagnation could go on for several years.  Currently what news that is good is just barely good, and the news that is negative is not terribly negative.  The trouble is that even though the economy may be moving in a positive direction, the movement is so slow that digging out of the tremendous hole that we have put ourselves in is going to take more and more time.  If that happens, it could begin to create more and more problems for both Republicans and Democrats who don’t have the political will (read guts) to deal with it.  It may take a real crisis that we are not really prepared to deal with to take whatever steps are necessary to get out of it..

Has anybody noticed lately that the “problem du jour” of the recession has subtly shifted from the crisis in small business lending to jobs and also, little by little, double-dip recession and deflation?   Lack of jobs is the key to just about everything as the recession rolls on.  But while the crisis in small business lending has been pushed off the front pages, credit availability for small business is as bad or maybe worse now than last year.  Beyond the unemployment situation, there are some other factors coming into play now.  One, from the banks’ perspective, is simple lack of loan demand.  When you read the results of the regular National Federation of Independent Business surveys, the biggest problem is not lack of financing, but lack of sales.  So when demand is weak, business owners are often leery of taking on more debt.  And because of lack of sales, revenues and profits may be decreasing, and banks generally are not willing to extend credit to businesses whose financial results are worsening.

Another problem for banks specifically is the current regulatory environment.  Bank examiners are going into banks and declaring various loans substandard or reclassifying loans that would have been performing in the past, forcing the banks to pay the penalty of placing more money in loan loss reserves.  This hurts bank profits and their ability to lend.  Aside from the fact that examinations are becoming much more stringent, which in many cases are needed, but the standards that FDIC examiners use are not the same as Federal bank examiners.  The FDIC regulates state-chartered banks and the Federal Reserve regulates national banks.  I was recently talking to an officer of a bank being examined by the Fed and he gave me an example of the problem.  There is a state-chartered bank in the same city, regulated by the FDIC.  The state bank has more non-performing and classified loans than the national bank.  Yet the Federal bank examiners made the national bank put more in loan-loss reserves than the FDIC did the state bank with a worse portfolio. 

In this kind of environment where there seems to be no consistency for banks to feel comfortable with, and where loans that are still performing are being classified as substandard.  For example, the banker told me about a loan that they had on their books to a land developer who had developed lots which were not selling.  The Federal bank examiner made the bank set aside a loan-loss reserve because the residential construction market is moribund.  It didn’t matter to the examiner that the developer had never missed a payment and was liquid enough to carry the lots for several years or just pay off the loan outright.  The examiner didn’t like the industry so the bank was penalized on a safe performing loan.  So it’s easy to understand that in this kind of regulatory climate that banks would be even more skeptical of making loans when they might incur the wrath of the examiners. 

Another side of the current regulatory environment is its impact on small businesses.  For example, the effects of the new health care laws now going into effect are still unclear as to what it might cost.  Congress fights over any regulation that could aid small businesses (or any other businesses) because of the hostile and uncivil climate in Washington.  If one party supports or proposes it, the other party almost automatically says no.  The public be damned.  Only getting re-elected is what matters.  Then there is the just-passed financial reform law.  It is a major bill with so many pieces and parts that no one has really had a chance to figure out exactly how it going to impact business.  So another uncertainty is thrown onto the fire.  So it may seem the safer choice for small business owners thinking of expanding or hiring to sit tight until they have a clearer picture of where the economy is going and what, if any, new laws and regulations will have on their businesses.

Finally there is the growing movement toward deficit reduction.  There is no question that the deficit is a huge long-term problem that must be addressed and corrective action taken; but to reduce deficits, you have to spend less.  And less spending in this economy which is showing hardly any signs of improving is exactly what the economy does not need right now.  Consequently, many banks and small businesses are waiting on the sidelines again to see what types of spending might be decreased and whether it could affect their businesses.  All of these things add up to a climate where banks are very leery to lend and small business owners leery of borrowing because there is not a clear sign of where the economy is headed.  As a consequence of these various factors, the current lack of financing is not going to improve any time soon whether there is money to lend or not.

“It ain’t over til the fat lady sings.”  That famous saying from the world of opera has another meaning today – she hasn’t sung, but she’s on stage and she’s singing.  It ain’t over yet, but optimism about meaningful economic recovery any time soon is fading.  Unemployment remains just under 10% with very little sign of improving.  More and more economic signals are showing less-than-positive or slowing trends. People that are working are beginning to show signs of spending less and holding on to their money until they see clearer signs of an economic recovery.  Personal savings rates are now approaching 6%.  Unemployment affects almost everything that can move the economy significantly.  Consumer spending and housing are two of the most visible of all and neither are showing any signs of improvement.  Deficit reduction is going to prolong the recession, so more layoffs are possible.  More and more states are beginning to lay off employees as the recession drags on and tax revenues continue to shrink because of lack of spending.

A counter-intuitive event that is currently happening in the American economy is that many large companies are reporting significant increases in profits on relatively small increases in sales.  This is because of the dramatic cost cutting that has taken place since the beginning of the recession, and most of those cuts have been accomplished by laying off employees.  A perfect example, although unusual because of its size, is Ford Motor Company.  Over the past five years they have shrunk their workforce by almost 50%, and many of those jobs may never be back.  So because demand is down for most products across the country, companies can meet the demand with the workforces that they have now and produce at lower costs, hence the increase in profits without having to hire.  And this is not going to change until sales begin to increase and they have to begin to hire again to produce product to meet demands.  But if people don’t have jobs they aren’t going to buy, so sales are going to be slow to increase, ….  So where does that leave us?

None of this bodes well for small business.  There are dozens, and probably hundreds of examples of why small businesses are particularly hard hit.  Take just one example – an auto body shop.  In “normal” times, if someone has a dent in their car, they would probably take it to a body shop to get it fixed.  But in today’s economy, as long as the car runs fine, maybe the dent can be lived with for a while.  This is already happening, and who knows how many other simple little decisions like this are being postponed – restaurants being one of the most obvious current example.  So a sustained recovery continues to be pushed farther away.  Without a sustained recovery that begins to increase sales and profits for small businesses, banks are likely to keep the credit spigots tightly closed.  The $30 billion small business loan fund that is being tossed back and forth in Congress (it’s not really the small business owners who are important) is going to do very little good because banks aren’t going to lend anyway to businesses that are not making money.  The potential haul for many small businesses is getting longer, and for many, the chances of survival are getting slimmer.